The principle of substitution plays a central role in resource allocation because it demonstrates that
A) firms will find it profitable to make abundant use of relatively scarce factors.
B) prices will be relatively low for those factors for which demand is high relative to supply.
C) firms can use all factors of production interchangeably with no impact on their costs.
D) methods of producing the same commodity will not differ from one country to another.
E) relative factor prices reflect relative scarcities of factors in the economy and so firms will find it profitable to make abundant use of relatively abundant factors.

Question

Quizplus · Accepted Answer

The principle of substitution implies that firms will try to substitute the relatively scarce factors with the relatively abundant factors. This is because the cost of production of a good or service will decrease as relatively abundant factors are used more extensively. Therefore, the relative factor prices reflect the relative scarcities of factors in the economy, and firms will find it profitable to make abundant use of relatively abundant factors.

The Principle of Substitution Plays a Central Role in Resource